Refinancings May Drop as Interest Rates Start to Rise

A decline in owners switching to cheaper loans and taking cash out of equity would be a blow to the economy.

The wave of home refinancings that bolstered the U.S. economic recovery is showing signs of ebbing next year as mortgage rates start to rise, house-price appreciation slows and the number of potential borrowers shrinks.

Homeowners will take out $751 billion in home loans next year to repay older, costlier debt, often taking cash out of equity in their homes, the Mortgage Bankers Assn. estimated. That would be just more than half the projected record of $1.4 trillion this year and down from $1.2 trillion in 2001. Mortgage rates may rise from 30-year lows as the economy recovers.

"The net effect of less refinancing next year is less stimulus for the economy," said David Berson, chief economist at Fannie Mae, the largest buyer of mortgages.

Makers of autos, home furnishings and other goods may have to work harder for sales as consumers' supply of new cash runs out. And until a recovery takes stronger hold, some consumers remain worried about their jobs. U.S. employers last month said they would cut 157,508 positions, down from 176,010 in October, according to placement firm Challenger, Gray & Christmas Inc.

Goldman, Sachs & Co. estimated that home-equity withdrawals, or "cash outs," accounted for half the rise in household spending since 2000. The boom fueled a 22% increase this year in the stock value of Countrywide Financial Corp., the largest mortgage lender.

Federal Reserve Chairman Alan Greenspan last month said money that consumers saved from refinancing helped counter the effect of this year's 19% decline in the Standard & Poor's 500 index. That has assisted an economy struggling to escape last year's recession, he said.

"A dollar of equity extracted from housing has a more powerful effect on consumer spending than does a dollar change in the value of common stocks," Greenspan said in congressional testimony Nov. 13.

The confluence of falling interest rates and rising home values that fueled the boom is coming to an end, according to projections by the National Assn. of Realtors and the Mortgage Bankers Assn.

"People who haven't refinanced already are running out of reasons to," said Phil Colling, an economist at the Mortgage Bankers' Assn.

Economists expect interest rates to increase next year as economic growth rises above 3%. The average weekly rate on a 30-year fixed mortgage monitored by No. 2 mortgage buyer Freddie Mac dropped from 8.64% in May 2000 to a record low of 5.94% last month. The rate has since rebounded to 6.13%, and economists, including those at Freddie Mac, predict it will rise to almost 7% a year from now.

The monthly payment on a 30-year, $200,000 mortgage at 7% is $1,330, or $130 a month more than a 6% loan.

"As interest rates rise, refinancings will fall," said David Parry, first vice president at Countrywide Financial Corp.

Fannie Mae and Freddie Mac last month raised the limit on the size of single-family home mortgages they buy from banks by 7.3%, to $322,700 from $300,700, widening the field of home buyers eligible for lower-cost financing.

At the same time, the rise in house values has slowed.

A 9.8% increase in prices over the 12 months through October, the steepest climb since July 1987, encouraged homeowners to refinance, take out cash and often cut their monthly payments. Now the appreciation of home values is expected to slow to an annual rate of about 4%, said David Lereah, chief economist at the National Assn. of Realtors.

The growth in national existing-home prices slowed during the third quarter, according to the office of Federal Housing Enterprise Oversight. Its new index of single-family home prices rose 0.84% in the third quarter after a 2.39% acceleration in the prior three months.

As interest rates rise existing-home sales will slip to 5.29 million from an expected 5.52 million this year, the National Assn. of Realtors said in a report Tuesday. The 2003 sales total still would be the third-highest on record and close to the 5.3 million homes sold in 2001.

The pool of those willing or able to refinance also has dwindled as homeowners raced to lock in low rates. Refinancings accounted for a record 70% of all mortgage applications in the fourth quarter of 2001, according to the Mortgage Bankers Assn. By the end of 2003, such applications will decline to 25%, the group said.